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Need A 401(k) Loan? It Just Got Less Dangerous

If you need money from your 401(k) before retirement, there are two ways to get it out: taking a loan or taking a hardship withdrawal. A loan is almost always the better choice, particularly after the December 2017 tax reform, because the new tax law liberalizes loan repayment rules. In short, it’s better to borrow from—than bust into—your 401(k).

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You can borrow up to $50,000, or half the balance in your account, whichever is less, from a 401(k) or similar workplace plan like a 403(b) or 457 plan. You then gradually repay the money, plus interest, to your own account.

Historically, 90% of borrowers have repaid 401(k) loans, according to a Wharton Pension Research Council study. But others fell into a trap: If you left a job, you typically had just 60 days to repay, or it would count as a distribution, subject to income taxes and a 10% early withdrawal penalty. Congress threw in a fix in the new tax law to help stem these defaults.

“Employers are concerned about 401(k) leakage,” says Joseph Adams, an employee benefits lawyer at Winston & Strawn in Chicago. “They’ll tell people leaving they have this new tool to repay their loan. It’s a nice change.”

The new law, which applies to loans taken after Jan. 1, 2018, gives workers a little more time. When you leave a job, you have until October of the following year (the due date of your tax return on extension) to put the money back into your 401(k) or an IRA or a 401(k) at a new employer. By paying the loan back, you avoid the tax hit and preserve your retirement funds.

By contrast, if you take a hardship withdrawal, you can’t repay the money to avoid a tax hit. Moreover, employees are barred from making any new 401(k) contributions for six months after the withdrawal. The House tax bill included a bipartisan provision that would have lifted that ban, but the final tax law did not include it.